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Hardinge (NASDAQ:HDNG)

Q2 2013 Earnings Call

August 08, 2013 11:00 am ET

Executives

Richard L. Simons - Chairman, Chief Executive Officer and President

Edward J. Gaio - Chief Financial Officer and Vice President

Analysts

Les Sulewski - Sidoti & Company, LLC

Christopher A. Bamman - Ascendiant Capital Markets LLC, Research Division

Operator

Greetings, and welcome to the Hardinge Inc. Second Quarter 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Karen Howard [ph], Investor Relations for Hardinge Inc. Thank you. Miss Howard [ph], you may begin.

Unknown Executive

Thank you, Kevin, and good morning, everyone. We appreciate your interest in Hardinge. On the call with me today, I have Rick Simons, Chairman, President and CEO; and also Ed Gaio, Vice President and CFO. Rick and Ed will review the results of the second quarter and also give an update on the company's outlook and strategic progress. You should have a copy of the financial results that were released this morning before the market opened. And if not, you can access it at the company's website, www.hardinge.com. You will also find on our website slides that accompany the discussion to which Rick and Ed will be referring. They can be found on the homepage next to the link for the webcast.

If you look then at the slide deck, on Slide 2, you will find our Safe Harbor statement. As you are aware, we may make some forward-looking statements during the formal discussion, as well as during the Q&A. These statements apply to future events that are subject to risks and uncertainties, as well as other factors that could cause actual results to differ from what is stated in today's call. These risks and uncertainties and other factors are provided in an earnings release, as well as in other documents filed by the company with the Securities and Exchange Commission. These documents can be found on the company's website or at sec.gov.

And with that, let me turn it over to you, Rick.

Richard L. Simons

Thank you, Karen [ph]. Good morning, everyone, and thank you for joining us for our second quarter 2013 financial review.

Sales for the second quarter of $81 million were down about $5 million from last year's second quarter as sales of $11 million from the Usach and Forkardt acquisitions helped to offset the measurable weakness in Europe. We are encouraged that overall sales improved 20% over the trailing first quarter, resulting from additional sales from our recent acquisitions and the improvements in Asian sales.

There's been improvement in business activity among the markets that we serve in China since the beginning of this year, and we began to see the orders and sales resulting from that activity in our second quarter. Sales to Asia strengthened from the trailing quarter by $8.6 million and were down just $1.6 million compared with last year's strong second quarter. The acquisitions had a nominal impact in Asia at this point. Although economic data points from China are somewhat uncertain, we continue to have a cautiously optimistic outlook for our end markets there.

As we had indicated in our last call, North America has remained relatively steady, plus or minus a few percent. Our sales to North America were up 26% compared with last year due to organic growth and sales from the acquisitions. When compared with the trailing first quarter, sales were up by $1.3 million in North America, with acquisition sales offsetting a slight decline in Hardinge's organic business.

Europe has been weak the last 2 quarters. Sales there were $25 million in the quarter, down 27% from the prior year, following the downward trend we saw in orders in the second half of 2012. The Forkardt acquisition helped to offset a major decline in the organic business with the addition of workholding parts and accessory sales. Including the acquisition, sales were up 18% over the trailing first quarter of 2013, and Hardinge's organic business held relatively steady. We believe that activity in Europe has stabilized, albeit at lower levels.

Before I turn the call over to Ed, I want to touch on our strategy to pursue growth and stronger-margin businesses, specifically grinding and workholding and aftermarket product sales. Our recent acquisitions of Usach last December and Forkardt in May demonstrate our execution of that strategy. Usach will be contributing meaningful sales and operating returns on sales in 2013. The more recent addition of Forkardt has gone well, and I'm excited about continuing to build upon their reputation for reliable, high quality, customized workholding solutions that the Forkardt brand carries. Also, this business historically has not experienced the severity in business cycles that the capital goods sector does.

As part of the Forkardt and Usach acquisitions, we incurred about $1.8 million of acquisition-related costs in the second quarter, which led to a lower level of operating income than we would normally have reached at these revenue levels. Ed will discuss this in further detail, but we are pleased that when excluding those costs and on a lower sales volume, adjusted earnings per share was $0.34 and shows an improvement over last year's second quarter EPS of $0.31.

With that, I'll turn it over to Ed who will provide more details on our operating and financial results for the quarter.

Edward J. Gaio

Thank you, Rick, and good morning, everybody. If you would, please turn to Slide 4.

Non-GAAP gross margin for the second quarter was 29.9% after being adjusted for a $0.8 million inventory valuation step-up associated with the Forkardt and Usach acquisition, which represents an increase of 2.1 percentage points over the prior year period. The improved gross margin was due to favorable product mix. When compared with the trailing first quarter, adjusted gross margin improved by 1.7 percentage points.

On Slide 5, you could see our non-GAAP operating margin was 5.8% in the second quarter, which excludes $1 million in acquisition transaction expense and the $0.8 million in inventory step-up charges. This was up slightly from the prior year's second quarter.

$2.5 million of incremental SG&A expenses associated with Usach and Forkardt were partially offset by savings from the reorganization of the U.K. sales structure that I talked about on our last conference call. And as a result, we were able to achieve an improved operating margin on a lower sales level.

We continue to expect SG&A to be in the range of $20 million to $21 million per quarter going forward.

Slide 6 shows non-GAAP net income for the quarter of $4 million, excluding the acquisition-related expenses I explained earlier, which is up from $3.6 million in the second quarter of 2012.

Overall, you can see that we have achieved greater margins on lower sales levels this quarter due to an improvement in our product mix. And with the addition of Forkardt, we expect that longer-term margins will be positively influenced going forward.

Slide 7 shows some of our key performance indicators that we follow to measure our productivity and cash generation. Our working capital as a percent of sales of 42% is up slightly from last quarter but remains well below historical levels. With the inherently high levels of finished goods and aftermarket parts and accessories that our customers require we have on hand, the machine tool industry has a high level of working capital needs.

Our inventory turns continue to be steady at 1.8 turns. And at that level, we believe we are performing well compared with our peers that are in the upper quartile of the industry.

Our receivable days outstanding are also steady at 57. And while they are lower than historical levels, we will continue to carefully manage our receivables.

On Slide 8, you can see some metrics that illustrate the strength of our balance sheet. Operating free cash flow for the second quarter was $7.9 million as we generated cash from income and effectively managed our working capital, compared with free cash flow of $0.5 million in the prior year period. Our debt levels have increased to $47 million as we used a combination of debt and cash to fund the Forkardt acquisition.

This morning, we announced that our Board of Directors approved entering into a sales agency agreement for an aftermarket equity offering. Our aftermarket program is intended to provide balance sheet flexibility going forward to facilitate acquisitions.

As we said in the past, acquisitions for Hardinge tend to become opportunistic as to when appropriate targets, usually privately held companies, are in a position to sell at a reasonable price. Raising funds by issuing equity at attractive levels in this cost-effective way and paying down debt will provide us with the ability to efficiently and quickly raise financings for growth opportunities in the future.

Capital expenditures in the first half in 2013 were $1.6 million, and we continue to expect capital expenditures of between $4 million and $5 million for the entire year, primarily for general maintenance requirements.

That concludes my remarks. And now, I'd like to turn it back to Rick.

Richard L. Simons

Thanks, Ed. Please turn to Slide 9 while I talk a little bit about what we are seeing in our end markets.

Our orders improved sequentially over the prior year in North America and Asia and were flat in Europe. The order improvement in Asia reflects the increasing activity in China that I've mentioned before. The activity is encouraging and the best we have seen in a while. We are finding success selling to our existing customer base, which seems to be bucking the overall economic trend there. We do believe there will always be short-term quarter-to-quarter volatility as customers' confidence reacts to economic indicators and government, fiscal and monetary initiatives.

North American orders benefited from the Forkardt acquisition, but it's important to note that Hardinge's organic business orders also improved when compared with both the trailing quarter and the prior year period.

In Europe, the recession there has clearly impacted the level of orders we received from the region over the last 12 months. As you can see, European orders have declined by almost $10 million from the prior year period, and that loss is net of incremental orders associated with Forkardt, indicating that our organic business deteriorated significantly. We are feeling that the market may have bottomed out there, but we continue to expect debt activity in Europe will remain weak.

On Slide 10, we've broken out our backlog by product line to help you better understand our mix of business, which has varying delivering -- delivery patterns. You can see the increase in grinding backlog that came with our acquisition of Usach in December, as well as our increase in workholding parts and accessories as a result of the Forkardt acquisition. Each of these product lines has a different lead time from the day we receive the purchase order to the date we ship the product to our customers. Most of the products we sell can contain a considerable amount of customizable content. And as a result, there can be a variance in the lead time from one product to another within a given line.

Grinding typically has the longest lead time of 6 to 9 months from book to ship. Milling and turning machines tend to have somewhat faster build times, and we stocked some finished machines. On average, we generally deliver these products to our distributors within 3 to 6 months of receiving the order. For some of these products, customers often demand delivery in less than a month, so Hardinge also carries finished machine inventories stored at some of our distribution locations. Workholding parts and accessories are much faster turnaround products, and a vast majority can be delivered in 1 day for standard products and 4 to 8 weeks for specials.

Slide 11 shows the most recent Oxford Economics machine tool consumption forecast that was published in the spring of 2013. As we have discussed before, the majority of future growth in this industry is expected to come in Asia, where they are forecasting a double-digit compound annual growth rate from 2012 to 2016, with China representing 70% of Asian demand by 2016. We've used a considerable amount of our resources to enable us to capitalize on this demand by expanding our manufacturing footprint there, and we look forward to growing with the market, as well as capturing additional market share.

Europe and the Americas are both expected to show 5% and 4% compounded annual growth rate from a much smaller 2012 base.

Of course, given that we deal in capital goods, orders for which are heavily influenced by the short-term confidence of the buyers, the nice smooth lines drawn in this chart are not how our sales and orders happen. Capital goods sales and orders can vary measurably by quarter, as we've seen from 2011 to this year. We do believe Oxford's opinions are valid long-term measures of market opportunity. Strategically, we believe building our workholding aftermarket business will also help to alleviate the significant cycles that we experienced in machine sales.

Please turn to Slide 12 while I recap our outlook for 2013. In the short term, we've seen activity rebounding in Asia, and we expect that acquisitions will help offset declines in Europe related to its weak economic climate and some softness in North America as the U.S. economy continues to moderate. As a result, we expect full year 2013 sales to be comparable with or slightly lower than they were in 2012.

As I've said, we continue to have a positive outlook for the machine tool industry in the long term and we are happy that, longer term, our margin profile has been strengthened with the addition of Usach and Forkardt.

We are focused on developing new, more advanced products to address the increasingly complex needs of our customers. Forkardt also addresses the need for customizable workholding products that manufactures value, providing solutions designed for their specific applications. We also continuously look for new ways to improve the reliability of our products and identify value that we can provide to our customers through our new product engineering and development efforts.

We continue to roll out our HIPEx Operational Excellence program and are educating the entire Hardinge team on the benefits of individually driving long-term results through improving productivity and efficiency at every level. We are in the process of creating a culture of individual accountability, which we expect will help expand upon our foundational values of high-quality product; excellent customer service; continuous improvements on our operating processes; a well-coordinated global organization; and employee education and development to provide our people with the tools to drive improvement in each of these areas.

With that, Kevin, we'd now like to open the call for any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is coming from Les Sulewski from Sidoti & Company.

Les Sulewski - Sidoti & Company, LLC

If we looked at the adjusted -- for the adjusted inventory revaluation, there's a pretty significant gross margin improvement, almost at 30% gross margin on a non-GAAP basis. Is this a similar rate we can expect for the second half of the year? I noticed -- you did mention that you expect some margin improvements, specifically from the Forkardt acquisition. But other than that, I mean, is this kind of a -- 30% a good rate to look at for the remainder of the year?

Richard L. Simons

That's always impacted by the mix of products that happen to go out the door in a quarter, and now it's probably the biggest impact on the second quarter. As we've said before, we would see that gross margin rate changing by as much as the percentage point, up and down in a quarter, but quarter-to-quarter because of the specific mix. So we had very good mix in the second quarter. I can't say right now what exactly the mix will be in the third quarter or the fourth quarter. But again, I would expect the rate that we -- or the margins we have to be within 1 percentage point of where we're at.

Les Sulewski - Sidoti & Company, LLC

And I see there the $2.5 million cost savings in SG&A from the sales structure change in the UK. If we go back to last quarter's call, your guidance for SG&A expense was roughly $20 million to $21 million per quarter. It looks like you came in at about $19.3 million this quarter on a non-GAAP basis. Can you provide a little more color on that?

Edward J. Gaio

Yes. Relative to the U.K. restructuring. We actually -- it kind of mostly happened towards the tail end of the first quarter. On an annual basis, the savings to SG&A was about a $5 million number. So this quarter here, we kind of saw the full impact of that quarter. And let us just -- to correct, the $2.5 million was the incremental cost associated with the acquisition, partially offset by the savings from the U.K.

Richard L. Simons

So cutting through all that, as we say in the slides, we are anticipating a $20 million to $21 million run rate on SG&A as we're structured today.

Les Sulewski - Sidoti & Company, LLC

Okay. So for this quarter, with the improvement of the structure change, it's kind of an offset quarter moving forward. It should probably be in the more to -- a little bit of a higher range, correct?

Richard L. Simons

Well, yes, but the reason being that we got the full quarter benefit of the cost reductions but only a partial quarter impact of the added costs from Forkardt.

Les Sulewski - Sidoti & Company, LLC

And then just a follow-up on the shift and the sales structure, are you seeing any mix in sales or any, perhaps like better pricing that you can offer your customers? Or any improvements there? Or is it a little too early to tell?

Richard L. Simons

Well, it's still -- actually, globally right now, I would say machine tool demand is down from what it was in all of 2012. And certainly, the first part of 2012. And, of course, we saw that in our results in the second half. China demand was down. And so I think -- pricing pressure is still out there very much. I mean, there is a -- at this time, I would say, compared to that global demand, probably overcapacity of machines, people are moving machines, most of our competitors sell throughout the world, and people are moving machines to where the hottest markets are, which, over the last 6 months, has probably been more of the United States. Certainly, Europe has not been good for the entire industry. China has been good for us, but I'm hearing it hasn't been as good for some other machine tool builders. So there's still lots of product out there. There's lots of inventory out there, and there are some very competitive -- aggressive competitors on the pricing side. So I don't see any additional pricing power short term.

Operator

[Operator Instructions] Our next question today is coming from Chris Bamman from Ascendiant Capital.

Christopher A. Bamman - Ascendiant Capital Markets LLC, Research Division

I was just curious, maybe you could provide a little bit more color on what you are seeing in the North American market. We had a strong PMI come out the other day, the strongest we've seen in a while. And just sort of maybe track how that's sort of gone through the month of the quarter and what you're sort of seeing in the first quarter? Just, any sort of improvement as you move along?

Richard L. Simons

Okay. Certainly, the AMT, our trade association that I'm on the board of, publishes monthly numbers on machine tool consumption. There's always a delay as they capture that data. The most recent one was through May, I believe. The one through June should be coming out shortly. But through May, the overall industry in North America, the orders for the overall industry were down 7.5%. And so I would say that's kind of the feel that we have as we've talked with our distributors, that it is down slightly from last year. I don't mean to discount 7.5% numbers being not significant. But realistically, a single-digit change, I'm not sure, represents a significant trend. It's more a short-term reaction to specific projects. And so overall, I think we're all feeling that North America is kind of steady as it goes. And we'll -- full year numbers will be below last year, but not dramatically below last year.

Operator

[Operator Instructions] If there are no further questions at this time, I'd like to turn the floor back over to management for any further or closing comment.

Richard L. Simons

Thank you, Kevin. To close, I'd like to thank you all for joining us for our second quarter 2013 business review, and we look forward to updating you in November with our third quarter results. Thank you, and have a good day.

Operator

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.

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